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As Sam Sees It: Is a Correction in the Cards for the Market?

(Equities.com Via Acquire Media NewsEdge) Each week, we tap the insight of Sam Stovall, Chief Equity Strategist for S&P Capital IQ, for his perspective on the current market.

For more from S&P Capital IQ, be sure to visit www.getmarketscope.com.

EQ: In this week's Sector Watch, you discussed the January Barometer, and a barometer for that barometer in the first five trading days of the New Year. Based on the minor stumble the market experienced in early January, what does that tell us about this month and potentially for the rest of 2014?
Stovall: If you take the direction of the market in the first five trading days of 2014 at face value, the implication would be that the market will be down in January and possibly be down or flat for all of 2014.

However, because I find that the first five trading days are really meant for people who are so impatient that they get upset if they miss a slot in a revolving door, investors are better off looking at the entire month of January to get a better read on what may happen for the entire year.

I think the January barometer is a good indicator because I believe investors are like dieters. They look to January as a new beginning, and it gives you an idea of those areas in which investors are likely to focus on for the coming year. It also gives you an idea on the overall direction of the market.

So even though the first five days were down, I would take a wait-and-see attitude, and would put more weight on the entire month's performance rather than just merely the first five days.

EQ: Considering that the S&P 500 closed 2013 at an all-time high on New Year's Eve, isn't it natural for the market to pullback just a bit during the following days?
Stovall: It's not surprising to see investors take some profits in the New Year following a gain of 20 or 30 percent so that it becomes a next-year taxable event. Also, there really has not been that many times since 1929 (six to be exact) in which the S&P 500 closed the year at an all-time high.

However, of the five prior times, the market gained an average of 8.5 percent in the subsequent year and rose in price four of five times. So using a very limited historical sampling, it would imply that momentum will likely carry forward into 2014, and we still end up with a good year with a high probability of a positive performance.

EQ: You also noted that the S&P 500 posted its first year-to-date decline since 2011. On average, the S&P 500 has posted a YTD decline of 5.5 percent, occurring in 86 percent of all years. How extraordinary is it for the market to go two years without posting a YTD decline?
Stovall: First, I want to explain what I mean by that. It indicates that the low point in one year has, on average, been 5.5 percent below the closing value of the prior year. In addition, the S&P 500 has posted a YTD decline in 86 percent of all years since 1900.

In 2012 and in 2013, even though we did see declines of 5 percent or more in each of those years, they occurred at levels substantially higher than the closing values of the prior year. As a result, we never saw a year-to-date price change on a closing basis that was negative.

This has only happened twice since 1900 in which we had a two-year stretch without a year-to-date decline, and that occurred in 1901-02, followed by 1975-76. So it is a fairly rare occurrence and I don't think I would be lauded as some genius if I was to say that the volatility is likely to pick up this year. We've already seen a year-to-date decline of more than 1 percent. Who knows? Maybe that number goes a little bit deeper before the year is out.

EQ: You also observed that in those two occurrences in 1901-02 and 1975-76, the market fell an average 15 percent following those two-year stretches. Is that a concern?
Stovall: Yes, however, if you're only looking at two observations out of 115 years, it's really not a lot to go on. So if I wanted to be sensationalist and to cause people to start biting their fingernails in nervousness, then I would emphasize that average price change in the subsequent years. But I'm not one to yell "fire" in a crowded theater.

EQ: S&P's target for the end of 2014 implies a 5 percent gain for the market. However, you also project a correction in excess of 10 percent. So is there some potential for higher gains based on that possible buying opportunity?
Stovall: Yes, because our belief is that we're not headed for a new bear market, and similar to what we saw following the correction of 2011, it could end up resetting a lot of the valuation dials and allow the market to continue its upward bull run.

I believe there's a very high likelihood of a decline of at least 5 percent or more, but more likely 10 percent or more, because we are currently 27 months beyond the last correction of 10 percent or more. The median separation of months has been 12 and the mean has been 18. So no matter which way you look at the average, we are well beyond the time. So the implication is that a correction is due.